Bill Nygren's Oakmark Fund gained 8% in the past quarter and 45% for the 2009 calendar year. Those gains compare favorably with the S&P 500 gains of 6% and 26%. “We continue to believe that stocks are attractively priced.” He wrote in his letter to shareholders.
Time Warner spin-off of AOL
Last quarter, when we were selling the AOL shares that Time Warner spun-off to its shareholders, I couldn’t help but think about how much had changed in just a decade. In January 2000, Time Warner and AOL announced their merger, and Time Warner effectively issued nearly $200 billion of its stock to buy AOL. We were certainly not alone in our belief that Time Warner was grossly overpaying (at the time, we didn’t own either stock). However, despite all the second guessing today, the prevailing view at the time failed to recognize what has become one of the worst mergers ever. In pre-market trading on January 10, 2000—immediately following the announcement—Time Warner stock rose by more than 40%, and AOL stock was up nearly 20%. Investors clearly cheered the union. But last month, a decade after the merger that valued AOL at nearly $200 billion, the AOL business returned to the public market with a capitalization of less than $3 billion. Even at that price we chose to sell our stock, because we believed that AOL was not as undervalued as our other holdings. Although ten years ago we correctly concluded that AOL was unlikely to grow rapidly enough to justify the multiple paid by Time Warner, we are humbled that we failed to forecast their poor business results. AOL’s business declining was not even one of the outlier possibilities we considered. That’s a pretty big miss given that their business has basically disappeared.
Comcast's Purchase of NBC Universal from GE
The AOL recap is a dramatic reminder of why, as value investors, we are reluctant to pay for highly priced businesses. It also demonstrates why our natural skepticism increases when we hear corporate managers try to justify the high cost of their acquisitions. So, as holders of Comcast, we were on alert when we read rumors that it might be purchasing NBC Universal from GE. We were concerned when we learned that GE bought out their minority partner Vivendi at a price that implied that 100% of NBC Universal was worth $30 billion. It wasn’t that $30 billion looked crazy for a company producing over $2 billion in EBITDA from cable TV networks. However, with Comcast’s own stock selling at about half of what we thought it was worth, a big acquisition at full value looked like a very sub-optimal use of capital. On December 3, Comcast and GE announced a joint venture that will result in Comcast eventually acquiring all of NBC Universal, and indeed, the announced value was $30 billion. There’s an old saying in the business world that if you can set only price or only terms, always pick terms. The Comcast GE deal is one of the most complex we’ve seen, but once you cut through all the terms, it becomes pretty simple. NBC Universal will borrow $9.1 billion and give the proceeds to GE. Comcast will pay GE $6.5 billion, and GE will also receive the excess cash flow from the joint venture for about the next seven years. At that point, the joint venture should have less debt than it started with, and Comcast should have 100% ownership of NBC. So, in summary, Comcast pays about 30% of the debt-adjusted value of NBC-Universal, gets operating control, and gets full ownership in about seven years. Not too shabby. By our calculation, this is not only a very undervalued acquisition, even before considering its probable synergies, but it adds more to our estimate of Comcast’s per-share value than a similar size share repurchase would have. We’ve always been admirers of Comcast management, but the favorable terms of this acquisition surprised even us. Further, the dean of value investors, Warren Buffett, also appears to have a positive opinion of Comcast management because he just added the company’s Chief Operating Officer, Steve Burke, to Berkshire Hathaway’s Board of Directors. We are aware that there are no guarantees about the future, but starting with a good price and good people—whether buying a stock or buying a business—sure puts the odds in one’s favor.
Applied Materials (AMAT — $14)
AMAT is the largest supplier of capital equipment used to manufacture semiconductors and LCD panels. It has the dominant market share across the vast majority of its product line, a world class service infrastructure, and a pristine balance sheet with over $2 per share in cash. Despite those positives, its business is wildly cyclical, and in the recent downturn, not many new semiconductor factories were built. In the technology frenzy a decade ago, AMAT stock reached a high of $57 which was 10x sales per share (yes, sales per share – it was almost 50x earnings per share). Sales in 2009 were about half the 2000 level, and AMAT lost money. But this is a growing industry, so we believe a strong cyclical recovery will soon produce sales and earnings that exceed the prior peak. On the basis of this business alone, we believe AMAT is undervalued at $14. In addition, AMAT has an emerging business selling equipment used to manufacture solar panels. The future of solar energy is hard to predict, and the value of AMAT’s solar division could range from almost nothing to half the current stock price if it were valued consistently with publically traded competitors. Though we aren’t comfortable valuing it at such a high level, it’s clearly worth something, and we don’t believe we are paying anything for it.
Wells Fargo (WFC — $27)
WFC is one of the largest bank holding companies in the United States. The majority of its business is still basic, community banking that services retail and small business customers. WFC has long been viewed as one of the best managed financial services companies, a view with which we concur. Though WFC stock has declined from a pre-crisis high of $45 in 2008, we believe it is one of the few banks that has grown its per-share value during the downturn. First, unlike most of its peers, WFC remained profitable while most banks incurred losses. Second, the acquisition of Wachovia, along with natural market share growth, has led to a more than doubling of its pre-provision earnings with only a 60% increase in shares outstanding. Credit losses are still running at abnormally high levels, so it will take a couple of years before the earnings power of WFC translates to reported EPS. But within two years, we believe investors will conclude that WFC has earnings power in excess of $4 per share, and that its plain vanilla business deserves a higher P/E multiple than its more complex banking industry peers.
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Time Warner spin-off of AOL
Last quarter, when we were selling the AOL shares that Time Warner spun-off to its shareholders, I couldn’t help but think about how much had changed in just a decade. In January 2000, Time Warner and AOL announced their merger, and Time Warner effectively issued nearly $200 billion of its stock to buy AOL. We were certainly not alone in our belief that Time Warner was grossly overpaying (at the time, we didn’t own either stock). However, despite all the second guessing today, the prevailing view at the time failed to recognize what has become one of the worst mergers ever. In pre-market trading on January 10, 2000—immediately following the announcement—Time Warner stock rose by more than 40%, and AOL stock was up nearly 20%. Investors clearly cheered the union. But last month, a decade after the merger that valued AOL at nearly $200 billion, the AOL business returned to the public market with a capitalization of less than $3 billion. Even at that price we chose to sell our stock, because we believed that AOL was not as undervalued as our other holdings. Although ten years ago we correctly concluded that AOL was unlikely to grow rapidly enough to justify the multiple paid by Time Warner, we are humbled that we failed to forecast their poor business results. AOL’s business declining was not even one of the outlier possibilities we considered. That’s a pretty big miss given that their business has basically disappeared.
Comcast's Purchase of NBC Universal from GE
The AOL recap is a dramatic reminder of why, as value investors, we are reluctant to pay for highly priced businesses. It also demonstrates why our natural skepticism increases when we hear corporate managers try to justify the high cost of their acquisitions. So, as holders of Comcast, we were on alert when we read rumors that it might be purchasing NBC Universal from GE. We were concerned when we learned that GE bought out their minority partner Vivendi at a price that implied that 100% of NBC Universal was worth $30 billion. It wasn’t that $30 billion looked crazy for a company producing over $2 billion in EBITDA from cable TV networks. However, with Comcast’s own stock selling at about half of what we thought it was worth, a big acquisition at full value looked like a very sub-optimal use of capital. On December 3, Comcast and GE announced a joint venture that will result in Comcast eventually acquiring all of NBC Universal, and indeed, the announced value was $30 billion. There’s an old saying in the business world that if you can set only price or only terms, always pick terms. The Comcast GE deal is one of the most complex we’ve seen, but once you cut through all the terms, it becomes pretty simple. NBC Universal will borrow $9.1 billion and give the proceeds to GE. Comcast will pay GE $6.5 billion, and GE will also receive the excess cash flow from the joint venture for about the next seven years. At that point, the joint venture should have less debt than it started with, and Comcast should have 100% ownership of NBC. So, in summary, Comcast pays about 30% of the debt-adjusted value of NBC-Universal, gets operating control, and gets full ownership in about seven years. Not too shabby. By our calculation, this is not only a very undervalued acquisition, even before considering its probable synergies, but it adds more to our estimate of Comcast’s per-share value than a similar size share repurchase would have. We’ve always been admirers of Comcast management, but the favorable terms of this acquisition surprised even us. Further, the dean of value investors, Warren Buffett, also appears to have a positive opinion of Comcast management because he just added the company’s Chief Operating Officer, Steve Burke, to Berkshire Hathaway’s Board of Directors. We are aware that there are no guarantees about the future, but starting with a good price and good people—whether buying a stock or buying a business—sure puts the odds in one’s favor.
Applied Materials (AMAT — $14)
AMAT is the largest supplier of capital equipment used to manufacture semiconductors and LCD panels. It has the dominant market share across the vast majority of its product line, a world class service infrastructure, and a pristine balance sheet with over $2 per share in cash. Despite those positives, its business is wildly cyclical, and in the recent downturn, not many new semiconductor factories were built. In the technology frenzy a decade ago, AMAT stock reached a high of $57 which was 10x sales per share (yes, sales per share – it was almost 50x earnings per share). Sales in 2009 were about half the 2000 level, and AMAT lost money. But this is a growing industry, so we believe a strong cyclical recovery will soon produce sales and earnings that exceed the prior peak. On the basis of this business alone, we believe AMAT is undervalued at $14. In addition, AMAT has an emerging business selling equipment used to manufacture solar panels. The future of solar energy is hard to predict, and the value of AMAT’s solar division could range from almost nothing to half the current stock price if it were valued consistently with publically traded competitors. Though we aren’t comfortable valuing it at such a high level, it’s clearly worth something, and we don’t believe we are paying anything for it.
Wells Fargo (WFC — $27)
WFC is one of the largest bank holding companies in the United States. The majority of its business is still basic, community banking that services retail and small business customers. WFC has long been viewed as one of the best managed financial services companies, a view with which we concur. Though WFC stock has declined from a pre-crisis high of $45 in 2008, we believe it is one of the few banks that has grown its per-share value during the downturn. First, unlike most of its peers, WFC remained profitable while most banks incurred losses. Second, the acquisition of Wachovia, along with natural market share growth, has led to a more than doubling of its pre-provision earnings with only a 60% increase in shares outstanding. Credit losses are still running at abnormally high levels, so it will take a couple of years before the earnings power of WFC translates to reported EPS. But within two years, we believe investors will conclude that WFC has earnings power in excess of $4 per share, and that its plain vanilla business deserves a higher P/E multiple than its more complex banking industry peers.
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